PRIVATE EQUITY

INVESTMENT PROCESS

Presentation for WIRC - ICAI

March 28, 2009

Structure of Presentation

‰ Introduction to Private Equity
‰ Private Equity Placement Process
Private Equity Placement Process
‰ Approaches to Valuation
‰ Due Diligence Exercise
Due Diligence Exercise
‰ Key Issues in DD/ SPA & SHA
‰ Certain Minimum Rights to PE Investors
‰ Monitoring
‰ Exit
‰ SEBI norms for private equity
p q y

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Global Private Equity Syndrome

1. Prematurely grey hair

2
2. Inability to remember city or country in which one is awakening
3. Persistent daze / jet lag / hoarse throat
4. Equating sleep on an airplane with real sleep
5. Inabilities to remember (or be present at) birthdays, anniversaries, or school
conferences
6. Contact with
C i h new friends
f i d concerned d about
b h ldi charitable
holding h i bl dinners
di i your honour
in h
or naming school buildings for you
7. Frequent
q musings
g about the fairness of p
pre‐nuptial
p agreements
g
8. Doubling of golf handicap every 6 months
9. Ability to schedule annual physical only every five years
10. Frequent spousal / child discussions about the value of sound estate planning

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Private Equity in India – Growth over the years

• Starting from a meagre five deals and a

total investment of USD 20 million in 1996,,
in 2007‐ 2008 USD 25 billion was invested
across 700 deals in 2 years
• Average deal size has come a long way
from USD 4 million in 1996 to ~USD 40
million currently
• Private Equity deals peaked in 2007 with
387 companies raising USD 14.2
14 2 billion
• First half of 2009 saw 93 deals raising a
total of USD 2.89 billion

Source: IVCA, Venture Intelligence, Grant Thornton 
, g ,
Years denote Calendar years

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PE Fund Raising for Indian Markets

• Total US$ 27 billion in Private Equity

capital has been raised in the last 4 years
by India focused funds
• More than 400 funds are active in the
Indian Market and around 100 of them
have been raised in the last four years
• At the start
ta t of 2009,
2009 78 PE funds
fu d weree e on
o
the road to raise US$ 24 billion funds for
India focused investments
• Some very large funds operating and/ or
Source: Preqin, VC Circle  being raised are infrastructure focused
Yea de ote Cale da yea
Years denote Calendar years

In all US$ 50 billion will be invested in Indian markets over the next 3 years
In all US$ 50 billion will be invested in Indian markets over the next 3 years
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Net FII and FDI Flows

Source: Reserve Bank of India, 
Data for 2009 includes flows from Jan – Sep 09
Data for 2009 includes flows from Jan  Sep 09

• FDI inflows have been on an uptick since the past few years
g in g
• Net FII flows are strong good market conditions but dry
y up
p in difficult
economic scenario
• Direct Investments are long term and considered stable, to help balance the
investment cycles
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Classification of Private Equity Funds (1)

Use leverage to do buyout deals, typically big deal sizes and long term
I. Buyout Fund ‰
g decision
financial and strategic

II. Growth Capital ‰ Classic PE investors providing capital to established businesses to attain
explosive growth through expansion – geography, products, delivery
Fund channels etc.

III. Proprietary Book ‰ Similar to a PE fund which can be either pure equity or structured to private/
public companies
of Banks

IV. Distress/ Special ‰ Funds focused on distress and invest in turnaround situations
Situation

V. Hedge Funds ‰ Public market fund with high return and high risk appetite, short term focus

VI
VI. Vent re Capital
Venture ‰ Typically provide the first round of capital to companies, smaller size and
long term horizon

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Classification of Private Equity Funds (2)

$6,000
Size in US$$ million

Buyout Fund
$5,000
Hedge Fund
$4,000

$3,000
Growth Capital
$2 000
$2,000
Fund S

Distress/ Special Situations
$1,000 Proprietary Book
Venture Capital
$0
0 2 4 6 8 10

Investment Time Horizon in Years

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PE – What do they bring besides Capital

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Challenges to PE in India

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The PE  placement process
T+2 T+4 T+8 T+12 T+16
Information 
Memorandum 
Circulation

K Business 
I Evaluation

C
K  Negotiations and
g
Term Sheet

O
F Financial  and 
Legal Due 
F Diligence

Share Purchase 
Share Purchase
Agreement and 
Closure

Weeks
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The PE  placement process

‰ Business plan review by financial advisors in conjunction 
Information
with the top management team of the company
p g p y
Memorandum
Circulation ‰ Preparation of sales collateral specific to the company and 
deal
‰ Varied forms of sales collateral are prepared by the Financial 
Advisors – Teasers, Information memorandum, Financial 
Model, Valuation Rationale etc.
Model, Valuation Rationale etc. 
‰ Short list PE investors based on industry, size of 
investment, type and stage of investment
‰ Touching base with the  targeted PE Investors
‰ Circulation of specific sales collateral

Wk 1-2

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The PE  placement process

‰ Initiating discussion with PE investors and review of 
Business
Information Memorandum
Information Memorandum
E l
Evaluation
‰ Financial Advisors continuously keep in touch with 
investors and help resolve queries of the investors 
‰ Further information flow and clarifications
‰ Market intelligence check on the business and industry 
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players
‰ Preliminary site visit and initial negotiations

Wk 2-4

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The PE  placement process

Negotiations ‰ Multiple rounds of Investor Meetings
And Term ‰ IInvestors get comfortable with the business 
t t f t bl ith th b i
Sheet model, industry, management and growth plans of the 
company and means and ways to achieve them
‰ Detailed negotiations on investment structure, terms and 
valuations
‰ Submission and signing of term sheet

Wk 4-8

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The PE  placement process

Financial and ‰ Law firm appointed for  legal due diligence

Legal Due ‰ CA fi
CA firm appointed for accounting due diligence
i t df ti d dili
Diligence
‰ Factory and site visits
‰ Client referral checks
‰ Detailed report of the findings submitted to the PE 
I
Investor 
t
‰ Any flags raised are discussed with the company and 
appropriate steps taken
appropriate steps taken

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The PE  placement process

Share ‰ Lawyers draft the Share Purchase Agreement on the lines 
Purchase of the term sheet executed between the investor and the
of the term sheet executed between the investor and the 
Agreement company
And Closure
‰ Process of fund transfer and share certificate issuance 
clearly defined and closing date confirmed to all parties 
involved
‰ Signing of SPA and transfer of funds to happen on the 
Si i f SPA d t f ff d t h th
closing date

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Approaches to Valuation
‰ Different assets may be valued using different valuation techniques.
‰ Usually there are three approaches to valuation which are as follows:

Approaches to Valuation
pp

Cost based Market based Income based

Net Asset Value Stock Market Quotes Profit Earning 

Capacity Value

Fair Market Value

Fair Market Value Market Comparables
Market Comparables Discounted Cash
Discounted Cash
Flows

Precedent Transactions

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Due diligence (DD) exercise
‰ Revenue and profitability trends
• Break‐up of various costs and operating margins
‰ Fixed Assets
Fixed Assets
• Schedule of depreciation
• Revaluation of assets, if any
‰ Investments
• Method of valuation of investments (subsidiaries if any)
• Ad
Adequacy of provisions
f i i
‰ Liabilities 
• Terms of the loans
‰ Inventory details 
‰ Extent of working capital finance 
‰ Taxation matters
‰ Contingent liabilities and implications thereof

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Due diligence (DD) exercise‐Cont’d
‰ Review of documents relating to title to property and other assets
‰ Review of leasehold agreements and comment on significant issues relating to the same
‰ Review of agreements, contracts entered into by the company with major suppliers and 
customers
‰ Review contractual arrangements with employees, trade union agreements and 
Review contractual arrangements with employees trade union agreements and
comment of potential liability if any 
‰ Review of all statutory compliance including status of licenses and permits essential for 
running the business
running the business  
‰ Review of current, pending or potential litigation / claims by or against the Company, 
or its directors and comment on potential liability
‰ Review of such other matters that maybe relevant to the transaction 

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Key Issues in Due Diligence

‰ Accounting Methodologies
‰ Past/ Current/ Future tax liabilities
Past/ Current/ Future tax liabilities
‰ Contingent Liabilities
‰ Legal contracts entered in to by the client with customers/ suppliers
Legal contracts entered in to by the client with customers/ suppliers
‰ Clearances specific to business
‰ Debtors greater than normal
Debtors greater than normal
‰ Corporate MIS

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Key Issues in SPA/ SHA

‰ Unusual findings from DD 
‰ Reps & Warrants
‰ Board Resolutions
‰ Indemnification
‰ Conditions Precedent

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Certain minimum rights to PE Investors

‰ Buyback clause
‰ In the event of IPO not being undertaken, typically in 3‐5 year timeframe, most investors 
include buyback clause for their investment exit. Such buyback arrangements can be with 
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either the Company; or – the Promoter
‰ Return Expectations: Depending on specifics of the investment, most investors typically seek 
dollar‐adjusted 18‐24% p.a. IRR

‰ Information requirements
‰ A private equity investor looks for several information rights including access to monthly 
MIS, quarterly financials and other confidential information presented to the Board apart 
from Annual audited account

‰ Board Representation

‰ Change of Statutory Auditor to Big 4 MNC firms

Change of Statutory Auditor to Big 4 MNC firms

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Certain minimum rights to PE Investors

‰ Anti‐dilution or Ratchet clause
‰ “Ratchet clauses” or “anti‐dilution protection” refer to mechanism through which investors 
p
protect themselves from significant dilution. For example, to protect oneself against the risk of 
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promoters diluting to friends and families or related entities at cheap valuation, investors 
typically seek “ratchet” provisions built in the conversion/buyback terms, wherein the 
conversion price is adjusted downwards or buyback clauses adjust for such dilution to allow 
investors protect the percentage holding/IRR
investors protect the percentage holding/IRR.

‰ Drag Along
‰ Investor shall have the right to drag along the holding of the Core Promoters and their 
Relatives and investment companies to the extent of XX% stake of the Company to facilitate an 
exit through a strategic sale or any other means. 

‰Tag Along
‰ In the event of the Promoters proposing to sell, assign, or transfer any of their equity stake in 
the Company exceeding XX% to any third party with the written consent of the Investor
the Company exceeding XX% to any third party, with the written consent of the Investor 
during the tenure of the Agreement, in a single transaction or a series of related 
transactions, the Investors, at their option, shall have the right to participate in the sale, in 
p p
proportion to their equity shareholding in the Company at that time.
q y g p y

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Certain minimum rights to PE Investors

‰ Customary Reps & Warrants
‰ Customary representations and warranties including, but not limited to, organization and 
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qualification, financial statements, accuracy and completeness of 
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information, authorization, execution and delivery, validity and enforceability of 
agreements, issuance of the shares, no material undisclosed liabilities, actions 
pending, compliance with laws and environmental regulations, governmental 
consent taxes insurance adequacy no conflict with agreements and charter
consent, taxes, insurance adequacy, no conflict with agreements and charter 
provisions, capitalization, taxes, no default, cause all employees and consultants to execute 
and deliver nondisclosure and development agreements for the term of their engagement 
with the Company plus six months in a form reasonably acceptable to the Board of Directors 
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and no material adverse change. 

‰ Cash‐flow
Cash flow Protection
Protection
‰ While a typical investor seeks significant say in the operations and management of the 
Company, we believe that on a minimal basis as well, given buyback provisions, such 
investors will like to monitor the cash‐flow of the Company and as such prefer to have a say 
i C i lB d i
in Capital Budgeting 
‰ Other cash outflow related decisions such as working capital management, etc.

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Certain minimum rights to PE Investors

‰ Voting Rights
‰ Term sheets often address issues of control in order to allow investors in a 
p y g g g
company to add value and also to exercise control if things go wrong. While 
investors may not want majority board control if things are going well, they may 
negotiate provisions that give them control if certain events occur. The golden rule 
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often applies: he who has the gold makes the rules. 

‰ Covenants
‰ Most preferred stock issues and debt issues have associated covenants, or things 
f d k dd b h d h
that the portfolio company promises to do (positive covenants), and not to do 
(negative covenants). They are negotiated on a case‐by‐case basis and often 
d
depend on other aspects of the deal. Failure to comply with covenants can have 
d th t f th d l F il t l ith t h
serious consequences to the company such as automatic default and payments 
due. 

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Monitoring

‰ The Investor post investment closely follows the growth of the investee company

‰ Makes sure the business plan presented during the investment is strictly 
Makes sure the business plan presented during the investment is strictly
followed

‰ Various ways in which a PE investor plays a role post investment:
a ious ays i ic a E i es o p ays a o e pos i es e
ƒ Steering the company through board representation

ƒ Making strategy for 5 years and

Making strategy for 5 years and  

ƒ Help in strengthening the management team wherever required

ƒ Marketing the company and its products within its network and do synergistic tie ups
Marketing the company and its products within its network and do synergistic tie‐ups 
cross sell within its investee companies

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Exit Modes Available

‰ IPO
‰ Divestment/ Secondary buyout
‰ M&A
‰ Leveraged Buyout (LBO)

‰ Buyouts
y
‰ Management Buyback
‰ Strategic Buyout
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‰ Management Buyout

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Mega Exits Through IPO

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Mega Exits Through Other Modes

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Guidelines for preferential allotment
‰ Special resolution of the shareholders must be passed under S. 81 (1A) of 
the Companies Act

SEBI Guidelines
‰ Issue price shall be not lower than the higher of the following
† Average of the weekly high and low of the closing prices of the shares 
during 6 months preceding relevant date i e 30 days prior to the date of
during 6 months preceding relevant date i.e., 30 days prior to the date of 
meeting u/s. 81 (1A) of the Companies Act
† Average of the weekly high and low of the closing prices during 2 weeks 
preceding relevant date
‰ Instruments allotted on preferential basis shall be locked in for 1 year

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SEBI takeover code
‰ Open offer 
† When the acquirer acquires 15% or more of shares

† Public offer should be made for minimum 20% of the voting capital of 
the company
† Offer price should not be lower than the highest of the following
Offer price should not be lower than the highest of the following
„ Negotiated price at which trigger limit was reached (15th percent)
„ Price paid by acquirer for acquisition of shares during 26 week period 
preceding public announcement 
e edi ubli a ou e e t
„ Average of weekly high and low of the closing prices of the shares of 
the target company during 26 weeks preceding date of public 
announcement
„ Average of daily high and low of the closing prices during 2 weeks 
p
preceding date of public announcement
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Questions ?

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